Realty stocks have taken a beating on the bourses. The beginning of fiscal 2011 saw improved sentiment towards them, but recent investigation of bribes related to loans given by public sector banks and financial institutions to realty firms led to them plummeting. The BSE realty index till date has contracted by around 39% since April, while the Sensex has returned 27%. Shares of leaders such as DLF Ltd and Unitech Ltd have fallen by about 10% and 17%, respectively. Other realty stocks such as Housing Development and Infrastructure Ltd (HDIL), Indiabulls Real Estate Ltd and Sobha Developers Ltd dipped 35%, 13% and 16%, respectively.

But has the investigation changed the fundamentals of realty firms? In a quick reaction, the Securities and Exchange Board of India has asked mutual funds (debt schemes investing for short- to medium-term liquidity) to keep real estate firms on the negative list. The Reserve Bank of India, too, has increased the risk weightage for retail home loans above ₹ 75 lakh.

Realty shares such as DLF, Unitech, Anantraj Industries Ltd, HDIL and Oberoi Realty Ltd are quoting at massive discounts of 30-80% of analysts’ estimated 12-month net asset value. While this does make them attractive value buys at current prices, investors must note that some challenges remain for the sector as a whole.

Meanwhile, despite higher sales and better prices, most realty firms were unable to reduce the debt component on their balance sheets significantly. DLF’s interest costs rose 74% year-on-year during the September quarter. Analysts reckon that most firms might have to resort to debt refinance by the end of fiscal 2011 as cash flows from sales appear insufficient to repay significant portions of existing debt. The impact of the investigations is likely to increase scrutiny, and perhaps the asset security needs, making refinance options tougher for realty firms.

It may tighten lending norms for big-ticket retail housing loans as well, which could affect offtake, as debt plays an important part in sustaining the property boom.

From an investor perspective, identifying the right real-estate stock is not easy. Unexpected project completion delays due to clearances or funding have led to significant cost-escalations. For example, Unitech has been among the realty firms with a healthy balance sheet and a debt-equity ratio of 0.4. But analysts say that recent problems in slum rehabilitation at Unitech’s Golibar project could lead to execution delays affecting financial performance.

Also, issues of transparency and disclosures still complicate the sector.

Hence, while valuations of the sector could be attractive, one has not been able to see sustained positive financial performance from most companies in the sector in the last few quarters. Until this changes, realty stocks could continue to underperform the broader market indices.